5 Ways to Maximize Your 401(k) - Especially If You're Young

By Farnoosh Torabi

Updated on: July 3, 2010 / 9:36 PM
/ MoneyWatch

A recent survey suggests young workers are pretty interested in retirement planning, despite being the "I want it now" generation. TD Ameritrade surveyed more than 1,000 young professionals aged 18 to 34, and found 60% plan to contribute more regularly to a retirement or long-term savings account this year.

Financial planners agree you can have a huge head start if you begin saving while in your 20s, and with many companies offering automatic enrollment to new hires, it's never been so easy to jump on the bandwagon. Here is some advice as you navigate the almighty 401(k).

1. Be Aggressive

You're young. You can afford it. It's easier to save aggressively now before your finances (and life) get busier. At the least, try to max out your employer's match (if available). Nearly half of the 401(k) plans out there have some sort of matching contribution and a good rule of thumb is to invest enough to at least receive the full match. Altogether, try to invest up to 10% of your income. The federal cap on annual pre-tax 401(k) contributions rose to $16,500 in 2010.

2. Mix it Up

For the most part, your 401(k) provider will let you invest in an array of stocks, bonds and cash. Remember to factor in your time horizon until retirement and your risk level. One common way to do this is to pick a life cycle fund that automatically shifts to bonds as you age. Moneywatch's Editor-at-Large Jill Schlesinger prefer index funds. Find out why here.

3. Go Easy on Company Stock

You don't want to hinge your retirement savings on any one company's performance - including the one you work for. (Just ask the former employees at Enron or Lehman Bros. - or even the current ones at BP.) A good rule is to have no more than 5% of your 401(k) in your company's stock.

4. Rebalance

Once you determine your allocation - let's say it's 75% stocks, 20% bonds and 5% cash - it's likely that the breakdown will shift with changes in the stock market over time. After a lousy year in the market, for example, you may end up with too much in bonds and not enough in stocks (because your stock holdings will have lost their value). Commit to rebalancing your portfolio at least once a year. Or, if your company offers it, opt for "automatic rebalancing." This gives your plan manager the authority to rejig your investments to maintain a certain allocation.

5. Avoid Early Withdrawal

Treat your 401(k) as a last-resort source of cash. Taking cash out of your 401(k) before age 59-1/2 may be considered premature distribution, which can carry a 10% penalty - plus any any tax that's due on the money.

Farnoosh Torabi is a personal finance journalist and commentator. She is the author of the new book Psych Yourself Rich, Get the Mindset and Discipline You Need to Build Your Financial Life. Follow her at www.farnoosh.tv and on Twitter at @farnoosh.